Sears: The Downward Spiral

By Ben Levisohn

When Nine Inch Nailsreleased the Downward Spiral, I’m pretty sure it didn’t have Sears Holdings (SHLD) in mind. Still, it might be an appropriate soundtrack after Sears released shockingly bad financial results this morning.

Associated Press

Sales at Sears fell to $8.01 billion, below analyst forecasts for $8.13 billion and the 30th consecutive quarterly decline. It also suffered its ninth GAAP loss in a row, according to Briefing.com.

Sears Holding reported another quarter of very disappointing operating results, results that point to its inability to hold on to share in its core categories without sacrificing further gross margin and increasing its record losses. To put that in perspective, Home Depot (HD) in Q2 had double-digit comparable appliance sales and it had no impact on its gross margins. Conversely, Sears, in an effort to not lose more share in appliances, was extremely aggressive in order to deliver positive comp sales results, but this came at a tremendous cost to gross margins. Gross margins declined 242 bps y/y in Sears Domestic, implying that it was buying sales through discounts and free delivery as consumers do not otherwise see the value of shopping in one of the worst service stores in America.

That’s a bad competitive position to be in, but at least the Sears Domestic segment was able to buy its sales. The Kmart segment had -1.9% comps on weak results in their core transactional categories (Grocery & Household), despite 221 bps of gross margin decline y/y.

What the overall results indicate is a continuation of a spiral further and further down in operating cash flow and at one point relevance. Sears size has been one of its biggest selling points to suppliers, who continue to fund the company’s operations even as operating cash flow remains at over a negative $1.5 billion per year. However, Sears efforts to sell assets to stay afloat, besides stripping out profitable Lands’ End and select Canadian stores, is leading to more store closures, implying overall sales will continue to decline, and at one point the company may lose its relevance with its key vendors.

In fact, Sears has been getting schooled not just by Home Depot, which reported stellar financial results earlier this week, but Lowe’s (LOW), Wal-Mart (WMT) and Target (TGT) as well, Balter and Kinder say. Consider:

A decade ago, Sears’ sales were $56 billion, compared to $73 billion at Home Depot and $36 billion at Lowe’s. Assuming the Sears Canada segment is disposed of by the end of this year and assuming 140 store closings but flattish comps, we estimate total volume for Sears will be down to ~$30 billion. We project Home Depot and Lowe’s will have sales of $83 billion and $56 billion, respectively. Home Depot and Lowe’s compete against the Sears Domestic segment, whose sales alone will be down to $18 billion in 2014 and it is important to note that this includes Sears Auto Centers and possibly other businesses the company plans to dispose of, which would make the sales gap even worse. And Kmart’s
positioning is even weaker, given its sales of $12 billion versus Wal-Mart, Target, and the growing dollar stores.

Let’s assume that suppliers stay with Sears and there does not appear to be a near-term reason to jump ship as only $92 million of term debt is due through 2017 and there are few clauses that should cause problems. The issue is that Sears has not shown an ability to stem the sales decline without giving up massive margin. This is the core problem the company faces as poor productivity leaves limited room for expense cuts and between Home Depot, Lowe’s, Walmart, the growing dollar stores, and
possibly a rejuvenated JC Penney (JCP) and Target, competition is fierce and there are no obvious share donors.

Shares of Sears have dropped 6.3% to $33.68 at 1:52 p.m., while Home Depot has advanced 0.4% to $91.07, Lowe’s has jumped 1.1% to $52.92, Wal-Mart has gained 1.1% to $75.80 and Target has risen 0.7% to $60.74. JC Penney has fallen 0.8% to $10.25.

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There are 8 comments

AUGUST 21, 2014 11:03 A.M.

steve wrote:

They used to have good products at good prices. Now they have cheap products at high prices.
All of their important lines have been plundered by competition .
In a year or 2 they won't exist ....

AUGUST 21, 2014 3:31 P.M.

John wrote:

I worked at Kmart in the late '70's - early 80's and it was a fantastic place where you could find stock on shelves, employees who cared, and took pride in their store. None of those things seem to matter anymore. If you make a positive experience for the consumer, better than the competition, they will come back to your store and shop again.

AUGUST 21, 2014 5:16 P.M.

Grendel wrote:

The current level of staffing, which has been gutted, is not conducive to happy customers. They are mired in a downward spiral, and frankly I do not understand how the stock has remained so high. If creditors believe they are getting a piece of Craftmans or Kenmore they are sadly mistaken. Both those brands are held in separate trusts and would not be part of any Sears bankruptcy.

AUGUST 21, 2014 9:15 P.M.

Roy wrote:

in the 70's when you want to buy appliances, power tools, garden supplies......Sears was the #1 choice with Brands consumers wants. they were ran by real merchants and operators that understand retail. Today a hedge fund manager is in charge with no experience ( by looking at the result). Edward Lambert maybe a great money manager but he is no master of all trades.........be humble and admit defeat and hire a really experience retail merchant to turn things around before it is too late.

AUGUST 21, 2014 10:08 P.M.

john wrote:

My 81 year old mother went to buy a new battery at the Sears auto center yesterday. Everyone used to buy a Die Hard battery, right? Well, they did not have a Die Hard and sold her something else that has a 1 year warranty, unlike the longer warranties the Die Hards used to have. They had some good brands back in the day.

AUGUST 22, 2014 1:37 P.M.

Matt J. wrote:

I guess this is what happens when you let Wall Street run your company (or country). You are screwed.

AUGUST 22, 2014 5:34 P.M.

Tim wrote:

As an ex (not disgrunlted) employee it was easy to see this coming. The most important asset any company has is it's employees. When they are relegated to part time, we do not care about you status , then any company will implode. Throw in a reduction in product quality and you WILL fail.

AUGUST 25, 2014 7:52 P.M.

David wrote:

Maybe if Eddie would have listened to some of his leaders, there wouldn't be this problem. And in the end, Allan Lacy had the best laugh.

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Earnings reports, corporate strategies and analyst insights are all part of what moves stocks, and they’re all covered by the Stocks to Watch blog. We also look at macro issues, investor sentiments and hidden trends that are affecting the market. Stocks to Watch gives you the full picture of the U.S. stock markets, all day long.

The blog is written by Ben Levisohn, a former stock trader who has covered financial markets for the Wall Street Journal, Bloomberg and BusinessWeek.